Mutual funds and market volatility

What is it about?

We investigate the empirical relationship between aggregate mutual fund flows and stock market volatility in Asian emerging markets by providing a comparative analysis of equity and balanced funds with market-wide volatility. Using a panel vector autoregressive model, we find that market volatility increases with increase in equity fund flows. However, it decreases with increase in balanced fund flows suggesting rational investment behaviour of balanced mutual funds. In addition, equity funds follow the market volatility positively, suggesting positive feedback trading (momentum) behaviour. On the other hand, balanced funds follow market volatility negatively and exhibit negative feedback trading behaviour (contrarian behaviour). We also show that macroeconomic variables influence both fund flows and market volatility. We discuss the implications of the findings for policy makers and portfolio managers

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Why is it important?

Our study contributes to the literature on stock market in general and mutual funds in particular in several important ways. First, it analyses the linkage between equity and balanced mutual funds with the market volatility. The study provides in-depth comparative analysis on the determinant of two main mutual fund classes i.e. equity and balanced mutual funds and their association with market volatility at macro level. Second, the study uses the economic variables as highlighted by Thomas et al. (2014) along with other variables (for example, investment growth, money supply, fiscal policy, and unemployment). These macroeconomic variables provide in-depth insight on the relationship among fund flows, market volatility and real economic activities.Lastly, the study adds new empirical evidence on flow-volatility relationship in Asian emerging market.

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